July was a great month for the major asset classes—prices rose across the board. It was the best calendar month overall for the markets since last November, the last time that all the broad measures of stocks, bonds, REITs and commodities posted gains in a single month. Indeed, the Global Market Index (a passive measure of all the major asset classes) rose 5.7% in July, its best month since May 2009.

REITs were the big winner, posting a 9.7% return in July. Equities weren’t far behind, particularly in foreign markets, in part because of the falling greenback. The 5.2% retreat in the U.S. Dollar Index (the biggest monthly decline in over a year) helped boost the dollar-based returns in stock markets in developed- and emerging-market nations overall. July’s rebound in stocks generally helped claw back a fair amount of the losses incurred after the previous two months of selling.
Is that the all-clear signal? Unlikely. The underlying economic worries that moved the crowd to sell in recent months haven’t gone away. A more plausible explanation is that the fading appetite for risk in May and June went a bit too far too fast.
Unfortunately, there’s still plenty of uncertainty about the macro outlook to keep volatility bubbling in the weeks and months ahead. The odds that everything is set to become hunky-dory is a long shot at this point, even for the most passionate optimist. The economic recovery continues to face numerous challenges, starting with the sluggish trend in job growth. Even so, it’s too early to throw in the towel and declare that all’s lost. The debate about how the Federal Reserve could ramp up monetary stimulus even at the zero bound is one reason to think twice before moving everything to cash and bonds (see, for instance, James Hamilton’s Options for monetary stimulus). Of course, for every positive there’s a negative to ponder these days, including the debate about what the Fed might do at this point, and when. As Paul Krugman writes today in his New York Times column:

It’s true that the Fed has already pushed one pedal to the metal: short-term interest rates, its usual policy tool, are near zero. Still, Ben Bernanke, the Fed chairman, has assured us that he has other options, like holding more mortgage-backed securities and promising to keep short-term rates low. And a large body of research suggests that the Fed could boost the economy by committing to an inflation target higher than 2 percent.

But the Fed hasn’t done any of these things. Instead, some officials are defining success down.

Meantime, there’s the argument that relative valuations have moved in favor of stocks. The bulls say that equities are attractively valued next to bonds, which have posted a strong run so far this year. The Barclays U.S. Aggregate Bond Index is higher by 6.5% through July 31. U.S. equities, meanwhile, are more or less flat. And with the 10-year Treasury yield dipping below 3% last week while corporate earnings have recently soared to record highs, some strategists think it’s time to raise equity allocations and cut back on bonds.
If your portfolio’s stock weight has dwindled sharply this year, there’s something to that argument. But it’s not yet obvious that macro salvation is at hand. This Friday’s employment report is expected to show that nonfarm payrolls shrunk by nearly 90,000 last month, according to the consensus forecast via Briefing.com. If so, it’ll be harder to dismiss the argument that the labor market’s recovery is sputtering. Indeed, nonfarm payrolls slipped modestly in June and another month of the same would suggest this trend has legs.
In turn, a weak jobs report would fire up the deflation talk. Indeed, by some accounts, the risk is a real and present danger. Deflation isn’t just a topic of intellectual curiosity, it’s happening, Bill Gross of PIMCO, the giant bond shop, tells the Wall Street Journal.
So, yes, July’s surge in asset prices is welcome news, but it’s shortsighted to think that a period of easy gains in everything has returned.